Timothy M. Doyle is Vice President of Policy and General Counsel at the American Council for Capital Formation (ACCF). This post is based on an ACCF publication by Mr. Doyle.

In an increasingly complicated investment and financial landscape, investors rely heavily on the services of data and analytics providers to support their investment-related decisions. Proxy voting is the process in which a vote is cast on behalf of a shareholder rather than that shareholder participating physically in a public shareholder meeting. The reliance on advisory services is readily apparent in the increased influence of proxy advisors like Institutional Shareholder Services (“ISS”) and Glass, Lewis & Co. (“Glass Lewis”). Due to their increasing influence, these normally private and opaque proxy advisory firms have come under fire for issues such as conflicts of interest, undue influence, privacy concerns, and the investment value their recommendations provide.

Lest readers think this is an issue with limited impact or import, proxy advisors drive major policies at most publicly traded companies. [1] They provide analysis, recommendations, and consulting services to issuers and companies alike regarding how annual and special proxies should be voted. Recommendations are made on issues ranging from Board appointments to acquisitions to environmental and social issues.

Academics, trade associations, and other institutions educated on this topic have called for reform. As former Securities and Exchange Commission (“SEC”) commissioner Daniel M. Gallagher remarked at a meeting of the Society of Corporate Secretaries & Governance Professionals in July of 2013:

“I believe that the Commission should fundamentally review the role and regulation of proxy advisory firms and explore possible reforms, including, but not limited to, requiring them to follow a universal code of conduct, ensuring that their recommendations are designed to increase shareholder value, increasing the transparency of their methods, ensuring that conflicts of interest are dealt with appropriately, and increasing their overall accountability. I am not alone in raising these issues…what European policymakers and our own Congress have highlighted is that changes need to be made so that proxy advisors are subject to oversight and accountability commensurate with their role.”[2]

In 2017, proposed legislation was brought to the floor aiming to bring a correction to the corporate governance and proxy advisor space: H.R. 4015—Corporate Governance Reform and Transparency Act of 2017 co-sponsored by Reps. Sean Duffy (R-WI) and Gregory Meeks (D-NY). The bill was proposed “to improve the quality of proxy advisory firms for the protection of investors and the U.S, economy, and in the public interest, by fostering accountability, transparency, responsiveness, and competition in the proxy advisory firm industry.” [3]

Specifically, the bill would require proxy advisory firms like ISS and Glass Lewis to formally register with the SEC and comply with the applicable rules and regulations governing all financial institutions. Within their filings, proxy firms would be required to disclose their potential conflicts of interest and codes of ethics. They would also be required to make publicly available their methodologies for formulating proxy recommendations and analyses.

This legislation would require some of the same baseline standards regulators have for financial institutions and credit ratings agencies to proxy advisors. The House of Representatives passed the bill in December 2017, but is awaiting review in the Senate. [4]

The complete publication looks at the rationale for the proposed reform, first exploring the history of the proxy advisory firms—how they came to be, their evolving role in the investment ecosystem, and their conflicts of interest. The paper then evaluates the influence proxy advisor recommendations have on shareholder voting, as well as how a mechanism called robo-voting exacerbates that influence. The following section then evaluates their increasingly activist stances on social, political, and environmental issues, and how these are impacting companies.

Key Conclusions

Proxy advisors have immense influence over the way large institutions vote on corporate issues. This paper cites numerous academic studies that provide quantitative details on the impact of ISS and Glass Lewis recommendations on a company’s proxy outcomes. Through an assessment of voting correlation data, this report also finds that institutions vote in-line with ISS and Glass Lewis recommendations the vast majority of the time—more than 80 percent of the time (on average) when the proxy advisors recommend in favor of a proposal, large institutional holders also vote in favor.

1. Proxy advisors have emerged as quasi-regulators with unchecked power. ISS and Glass Lewis have asserted themselves into a role of regulator, wielding the aforementioned influence to require disclosure across public companies, without any actual statutory requirements. A proxy advisory recommendation drawn from unaudited disclosure can in many cases create a new requirement for companies—one that has added cost and burden beyond existing securities disclosure.

2. While often characterized as “neutral” arbiters of good governance, these firms are very much for-profit enterprises. By design, proxy advisory firms are incentivized to align with the comments of those who pay them the most and to move targets and change policy to create a better market for their company-side consulting services. This problematic offering further complicates the role of proxy advisors and creates a problematic conflict of interest.

3. Shifting policy has costly impacts for companies. Consistent policy changes, which are influenced by a non-public annual comment process, move the goalposts for companies, creating burdensome and costly requirements not mandated by law—these burdens are amplified for small and mid-cap companies. While changes to ISS and Glass Lewis’s policy recommendations may appear small at any given moment, taken in aggregate this constant evolution has significant ramifications for companies and often adds burden and cost.

4. Proxy advisors create particular challenges for smaller public companies. The quasi-regulatory authority creates a bias in favor of large-cap companies with the resources to comply or create a campaign to oppose. This, in turn.creates difficulty for small- and mid-cap companies.

5. Robo-voting in line with proxy advisor recommendations undermines fiduciary duty to investors. There are institutions, particularly in the quant and hedge fund space, that automatically and without evaluation rely on proxy firms’ recommendations. In addition to potentially breaching fiduciary duty, this extends the power and impact of ISS and Glass Lewis policy recommendations and decreases the ability of companies to advocate for themselves or their businesses in the face of an adverse recommendation.

Ultimately, proxy advisory firms have become intricately woven into the investment landscape. These institutions have essentially become shadow regulators, with implications for the operations and disclosure requirements of companies. As increasing attention is brought by actual regulators and elected officials, it is worth examining the biases, conflicts, and activism of these powerful institutions.